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Strict Compliance in Documentary Credits

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Essay Answer Guide on Strict Compliance (Qn 3 2009 (B))
‘The strict compliance rule in relation to letters of credit does not require exact literal compliance in all circumstances and as regards all documents. The bankers is, therefore, required to exercise judgment whether the requirements has been fulfilled.’
Discuss.

The use of letter of credit is the most common way of financing in an international sales agreement. Donaldson LJ in The Bhoja Trader had even seen it as “the lifeblood of commerce”. The documentary credit system (DCS) is useful in that it gives sellers greater assurance of being paid for goods supplied while allowing buyers to open a line of credit and facilitating effective payment. Before releasing payment though, the bank would have to ensure that documents tendered by the seller strictly comply with the buyer’s mandate. This strict compliance approach will protect the buyer’s interests.
The doctrine of strict compliance has been justified in the context of commercial letters of credit on two grounds. First, on principles of agency (and contract) law, where the issuer must act within the mandate given by the applicant and obtain documents which comply strictly with the applicant’s instructions. Documents which go outside the mandate do not entitle the issuer to reimbursement. Secondly, the doctrine ensures that the issuer obtains documents which are commercially marketable and can be used in case the goods are lost or destroyed. The aim is to give the buyer the documents which are valuable or protective
The doctrine also serves the objectives of certainty and reliability of the banker's credit.
Significantly, it would be unreasonable to a bank to be familiar with different trade customs and trade terms and that a strict compliance approach promotes greater efficacy to the banking system. Thus the importance of this doctrine to the banks are: banks can only be expected to be familiar with banking practices and not the underlying commercial practices or terminology; the banks act as agents of the applicant and must remain within the terms of their mandate to ensure repayment; allows banks to take quick decisions.
The strict compliance doctrine allows banks to reject documents which do not strictly comply with the terms of the credit. The bank is acting as a special agent with very limited authority.
To be fully certain that they are acting within their ‘actual authority’, banks might require that documents tendered ‘exactly and literally’ match the terms of the credit. By exercising their own judgment and releasing payment even where there are slight discrepancies, banks may potentially be acting outside their authority, and the buyers may choose not to reimburse them. The statement is therefore inaccurate here as banks have been reluctant to exercise discretion, choosing instead to adopt ‘exact literal compliance’.
It is noted that ‘strict’ is not an UCP expression, but a ‘judicial interpretation’ which originated from the decision in Equitable Trust v Dawson. Viscount Sumner had stated that
“there is no room for documents which are almost the same, or which will do just as well”.
Banks will be paying at their own risk should they choose to pay against ‘almost perfect’ documents. This need for perfection is further demonstrated in Seaconsar v Bank Markazi
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where there was a requirement that all documents submitted had to have the number of the letter of credit and the buyer’s name on them. That even one document failed to satisfy this, was held to be fatal. In Moralice v F Man, the courts did not recognise the de minimis principle and held that even a 0.06 % shortfall in goods justified rejection.
Furthermore, in Rayner v Hambros Bank, where the sellers presented documents referring to “machine shelled groundnut kernels”, the bank was entitled to reject payment. The term used in the buyer’s mandate was “coromandel groundnuts” and even though the terms used were interchangeable, the banks were not expected to know all the different trade customs involved in the transaction. As reflected in Art 4 of UCP 600, banks ‘deal in document and not in goods’. In the same vein, Art 14 (a) requires banks to examine whether documents presented “constitute a complying presentation”. Also, Art 18 (c) also states that description in commercial invoice must correspond with that appearing in the credit. Without prior knowledge of trade customs, banks relying on just the words in the documents and credits would likely take ‘complying presentations’ to match word-for-word.
So all the above seem to show that the doctrine is indeed one of strict compliance.
There are, however, exceptions to strict compliance as an overly rigid rule lead to unfairness.
The Uniform Customs and Practice for Documentary Credits (UCP), being the governing standard, has in some ways mitigated the ‘harshness’ of the strict compliance rule by allowing a degree a discrepancy and flexibility between documents tendered and the terms of credit. As mentioned above, Art 18 (c) expressly states that ‘invoices’ must correspond with the credit. Therefore, other documents besides the invoice might not have to be strictly identical. This is supported by the provision giving in Art 14 (e) which allows the description in documents to be in general terms, provided it is not inconsistent or conflicting with the description in the credit. Additionally, Art 14 (d) states that data in documents need not be identical with that in the credit and allows the documents to be “read in context”. This contextual approach was evident in Glencore International v Bank of China, where it was held that documents should be read together and not separately. So even where there was apparent inconsistency in the documents, the banks should have accepted them as the additional information supplied was not detrimental. Exact literal compliance is also not required as Art 16(b) allows the issuing bank to approach the applicant of credit for a waiver of the discrepancies. Finally Art 30 also provides for tolerance levels such that quantities do not have to be exactly the same.
Bankers have recognized the need for a more commercial approach for some time and this has lead the ICC to promote a more flexible approach to documentary compliance where the strict compliance rule is modified by “a functional standard of document verification” now enshrined in Art 14(a) which provides that compliance of the stipulated documents on their face with the terms and conditions of the credit, shall be determined by international banking practice as reflected in the other Articles.
Common law also demonstrates a certain degree of
‘trivial discrepancies’, the banks may be allowed to nonetheless. This was shown in Bankers Trust v number of the buyer on the relevant documents was
2

being liberal. In cases where there are ignore them and accept the documents
State Bank of India where the telex different from that which was given. It

was nothing more than a typographical error. Similarly, in Hing Yip Hing Fat v Daiwa
Bank, the documents were accepted even though the word “industrial” was different from
“industries”. The bank may also clarify any ambiguity in relation to the buyer’s instructions, as held in European Asian Bank v Punjab & Sind Bank.
However, the judicial attitude in such ‘trivial discrepancies’ cases seem to be inconsistent when seen in light with the strictly decided cases above. Arguably, with these cases, the law seems uncertain and this is not particularly desirable in mercantile practice.
In a final analysis, it is submitted that the UCP and the courts have taken a middle position in this apparent conflict and dichotomy. This can be reflected in the modern approach as espoused by Evans LJ in Kreditbank v Midland Bank where the approach taken was that banks may adopt a reasonable and functional approach to the doctrine and need not rely on a literal mirror image principle. They should exercise their own judgment on whether the requirements are satisfied by the documents presented. The statement in the question was stated by Evans LJ where he said that ‘the requirement of strict compliance is not equivalent to the test of exact literal compliance in all circumstances and as regard all documents. To some extent, therefore, the banker must exercise his own judgment whether the requirement is satisfied by the documents presented to him’. This is indeed in line with the direction given in
Art 16 (a) of UCP 600 which says that banks “may refuse” to accept non-complying documents, instead of using an absolute connotation like “must refuse”. It is also evident based on the above-mentioned discussion.
It is submitted that having a more relaxed approach also makes more practical sense for banks. A survey carried in the UK by SITPRO (formerly Simpler Trade Procedures
Board), in 2003 indicates that the rejection rate of first presentation against letters of credit lies in the range between 50-60%. A more recent survey show found that up to 70% of documents were non-compliant on first presentation. Clearly, such an overly strict approach would likely hamper the operations and reputation of banks. Prof Boris Kozolchyk had commented that the strict approach is unhelpful to commerce though it could be helpful to
‘dumb high school graduate as document checker as mirror image examination is convenient, being mechanical’.
Though the UCP and common law has seemingly ‘softened’ the strict compliance doctrine, its application still depends on whether the parties intend for it to be. It is submitted that the intention of the parties will still be key in determining the extent of strictness that the courts will adopt and this will be on a case-to-case basis based on what the parties intend. So, for example, in a similar case, like Seaconsar, where the Applicant had very clearly required for every document and every copy to have certain information – it is likely that the courts will then interpret this strictly so as to uphold the intention of the parties. It would not be wrong to assume that such strict cases will still continue to be decided the same way despite the changes made to UCP and the modern approach as stated in Kredietbank.
Bernard Wheble commented that “it still has to be appreciated, that UCP are not, and cannot be, intended to give a precise answer to each and every problem arising in practice”. He advocates that UCP needs to be supplemented by what can be described as a form of
3

education, with a constant readiness on the part of those who have the knowledge to impart it, and a matching willingness on the part of all concerned to receive it and act on it.
The DCS might not yet be a ‘perfect’ system, but the law has been progressively seeking to seek a fair balance between the interests of all parties involved. Perhaps the principle of
“substantial compliance” which is recognised by the Italian courts could be adopted in the
UK too. This requires skill and depth of knowledge for deciding what error to accept or disregard. It would be risky for banks who would be taking on greater responsibilities, but helpful for beneficiaries. This risk though, could be transferred through waiver [Art 16(b)].
Already the move away from the traditional doctrine of strict compliance has been seen in the
Kreditbank case.

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